Special Purpose Acquisition Companies (SPACs) Part 1
Part 1: An Overview
Special Purpose Acquisition Companies (SPACs) have been the center of the capital markets stage, and with good reason. Private equity firms, hedge funds, and other financial institutions are looking to SPACs as a flexible and efficient way to acquire companies. On the other side of the equation, target companies see SPACs as a simpler path to the public market, with enhanced valuation certainty.
The SPAC Structure and Lifecycle
A SPAC or “blank check” company, is a shell company with no commercial operations, formed purely to raise capital via IPO to acquire one or more existing companies that will be later identified.
Led by a management team, the SPAC undertakes an IPO to raise capital from retail and institutional investors. In return, investors own units in the SPAC, with each unit comprising a share of common stock and a warrant to purchase more stock at a later stage. The purchase price per unit is usually $10.00, and 52 to 60 days after the IPO, the units become separable into shares of common stock and warrants, which can be traded in the public market.
Money raised in the offering is held in a trust account until the SPAC team finds a suitable acquisition target. They then use the proceeds of the offering to acquire a private company in a reverse merger. That is, the target company receives the money held in trust, and the SPAC shareholders obtain shares in the new combined company. Ultimately, the target company has raised cash and gone public through the merger.
The SPAC process can generally be broken down into three phases.
- 8 to 10 weeks—the IPO phase: Includes submitting the S-1 documents, negotiating the underwriters, going on the roadshow, and pricing the SPAC units.
- 18 to 24 months—the target search: Once the SPAC has raised funds in the IPO, the sponsors aim to find and announce a target company within a prescribed timeframe, typically 18-24 months, depending on the industry.
- 3 to 5 months—the “de-SPAC” process: Once the target company has been announced, the necessary approvals, documentation, and other negotiations occur.
As a result of the transaction, the SPAC founders will profit from their stake in the new company, usually 20% of the common stock, and the investors receive an equity interest according to their capital contribution.
If the management team fails to identify a target within a prescribed 18 to 24 month period, the SPAC is dissolved, and proceeds are returned to the investors with interest.
The Appeal of SPACs through the Lens of SPAC Sponsor
The benefits of SPACs for private equity firms are multiple. Perhaps the greatest appeal for SPAC sponsors is the considerable economic stake of 20% of common equity in the SPAC, referred to as the “promote.” The promote requires a much lower upfront investment—usually a nominal amount of $25,000—compared to a typical sponsor buyout.
Accessing capital from the public market allows SPAC sponsors to access a broader investment base as it eliminates the time commitment and investment criteria typically attached to raising funds from LPs in the private market. Sponsors can then pursue larger acquisition targets and more speculative or emerging industries that fund documents might usually prohibit them from investing in.
A SPAC can also serve as a commingled investment vehicle, allowing multiple private equity sponsors to invest side-by-side with greater equity and less leverage. This is especially appealing given the limited target universe and increased competition for assets.
Why Sellers are Looking to SPACs over IPOs
In the current environment of volatility and uncertainty, sellers are turning their attention to SPACs as a way to exit through the public markets with more control, certainty, and ease.
Although still subject to certain regulatory reviews, the SPAC process offers companies a simpler path onto the public market. Time to completion can be as short as three to four months – less than half of what they would endure in a traditional IPO process. There are various reasons for this accelerated process. All filings for the SPAC relate to the shell company, so financial statements are short and can be prepared within weeks, in contrast to an operating business, which may take months. The IPO registration statement is mostly boilerplate language since there are no historical operations, assets to be described, and business risk factors are minimal.
With a SPAC merger, the IPO roadshow has already been completed and funds raised. Bypassing the roadshow process has been particularly appealing to companies throughout the pandemic, as travel and in-person meetings have been made more difficult. A condensed process also means companies need to invest much less time, resources, and management attention, compared to a traditional IPO.
A SPAC transaction is especially appealing to target companies because it eliminates pricing uncertainty. The company can negotiate an exact purchase price with one investor—the SPAC—rather than the wide spectrum of prospective backers in a traditional IPO where pricing is influenced by investor appetite and market forces. These narrowed negotiation parameters hold significant value against the backdrop of volatility witnessed throughout the pandemic, where pricing an IPO on a bad day could detriment the company’s valuation. Founders also typically do not have to give up as much control when merging with a SPAC and hold stronger negotiating power against a single party.
Particularly relevant for growth-phase companies or those not yet highly revenue generating, is the ability to provide forward-looking financial projections. In a SPAC merger, the target company can provide forecasts, which are often not utilized in a traditional IPO process. This visibility of a growth plan can generate investor interest that companies may not be able to achieve otherwise.
Next in the Series
It is clear why SPACs have gained such significant traction throughout 2020 as an alternative to the traditional IPO. And with no sign of slowing down, momentum is expected to continue in the coming years. In part two of the series, we will dissect learnings from SPAC activity in 2020 and discuss the outlook for 2021.